Another Goldman SNAFU: GS Upgrades The Stock Of Erste Bank, Even As It Is The Lead Underwriter Of An "In Progress" Rights Offering

Those brave or stupid enough to venture to the website of Austrian financial cadaver Erste bank (the one European bank with possibly the most exposure to Central and Eastern Europe and an associated assortment of perfectly unviable, massively overextended crediting over the past 5 years), will be greeted with this jolly announcement: "For educated realists only."

As it turns out, the "educated realists" universe is confined only to individuals from Austria, the Czech Republic and Romania, and represents a Rights Offering which is supposed to raise €1.65 Billion via an offering of 19% of the stock (i.e., massive dilution), in order to replenish the firm's depleted capital base. The bank is fully aware that as the credit tsunami in Europe unravels from the IMF's and Germany's attempts to continue postponing it, it would be faced with massive losses, so, as expected, it is taking advantage of a capital raising window to fool not too bright investors into purchasing its stock at stratospherically high levels. Surprisingly, a feature of this particular Rights Offering, is that instead of being offered at a traditional discount to a given price, in the way most R.O.'s are conducted, this one would get done at market prices, and specifically, the final transaction price, which is currently unknown, would be made public "on or about 17 November 2009" by Erste and its Joint Bookrunners. While the price is capped by a theoretical ceiling of €32, this is a price that is well below its 52 week high, which it appears it may hit again today, courtesy of the key Joint Bookrunner.... Goldman Sachs.

Enter Goldman Sachs (you were expecting?)

A casual glance at the cover of the prospectus, and you will already know how this story ends:

So let's recap: on October 29, Erste, with Goldman as main underwriter and advisor, announces it is offering 60 million shares of stock at what are essentially market prices, with the final price determined by the stock's action during the period from the announcement and November 17th. It is of course in Goldman's best interest to get the deal done as close to the cap as possible, as its underwriting fee is a function of the total value raised. On October 29, it seemed that a closing price anywhere close to the cap would be impossible, but then things changed. The chart below shows the diagonal upward move of the stock price since the announcement: 20% dilution be damned, Goldman is running the show and controlling the market.

Indeed, quite an impressive move: from a post-announcement low of €24.50, the stock has moved all the way to €31.15, a 27% ramp on no news: just 20% dilution...and an underwriter.

But just what an underwriter: the kind that will would allegedly breach all ethical and fiduciary gray lines, and on November 6, a mere week after the announcement, come out with a research report stating that it is raising its target stock price on Erste from €30 to €33 (just above the offering cap threshold), with the catalyst being, among other things, the offering itself.

Goldman is raising the target price of a company, for which it still in the process of soliciting stock interest until November 17th (one would imagine some sort of analyst quiet period would be in force, if noting else), only so it can be paid more, as the higher the price the deal is done at, the more money Goldman recoups: a preliminary estimate given by the prospectus on page 65 is that Goldman will end up with the lion's share of roughly €58.6 million (a number that will fluctuate only based on the final deal price). What is truly flagrant, is that Goldman is using this very underwriting whose success is dependant on Goldman's actions, as a catalyst for the stock upgrade. We are fairly confident that this is one of the most unprecedented circular upgrade-cum-underwriting practices that we have yet witnessed. And, of course, no one cares: not the SEC, not the Austrian regulators (assuming Austria even has any), and least of call, not Goldman's clients who buy Erste stock as a result of the upgrade. Because as we all know, the invisible Goldman-generated bid under the stock will be there just long enough to price the offering. After the wire transfer to Goldman for a job well done (we venture to guess about €40 million is the invoice for this clever Goldman-hatched scheme) the game of who can dump the stock the fastest begins truly in earnest.

As for the real price of the stock: check back in one month - we are rather confident Erste shareholders (those who buy today that is) will be in for a very unpleasant surprise. Some may call them "educated realists" ... other may prefer the term "broke."